New Fee Disclosure Rules Require Action by Plan Fiduciaries and Service Providers of Defined Contribution and Defined Benefit Pension Plans
The Department of Labor (“DOL”) recently released an interim final regulation that, once effective, will obligate service providers of certain types of defined contribution and defined benefit pension plans to disclose information that will enable the plans’ fiduciaries to (i) assess the reasonableness of the contracts with, and compensation paid to, their service providers and (ii) determine if there are any potential conflicts of interest that may affect the service providers’ performance.
Background
As a general rule, ERISA prohibits the furnishing of services between a plan and a “party in interest.” A “party in interest” includes any person providing services to the plan. However, certain contracts and arrangements between plans and service providers that otherwise would be prohibited under ERISA are permitted if the contracts and arrangements are reasonable, the services to be provided thereunder are necessary for the establishment or operation of the plans, and no more than reasonable compensation is paid for the services. The new DOL fee disclosure requirements provide that contracts and arrangements with service providers will not be considered reasonable unless the new disclosure rules are satisfied.
Effective Date
The new requirements will apply to all service contracts or arrangements between covered plans and service providers on and after July 16, 2011 (including those in place at that time but entered into prior to that date).
Plans Subject to the New Requirements
Plans covered by the new disclosure requirements include defined contribution and defined benefit pension plans other than simplified employee pension plans, simple retirement accounts, individual retirement accounts and individual retirement annuities. The new requirements do not apply to plans exempt from ERISA such as governmental plans, church plans and unfunded excess benefit plans. The DOL has reserved specific authority to develop a different set of requirements for health and welfare plans.
Service Providers Subject to the New Requirements
The new disclosure requirements apply to any service provider who enters into a contract or arrangement with a covered plan to provide certain services and who reasonably expects to receive $1,000 or more in compensation (whether direct or indirect) pursuant to the contract or arrangement, regardless of whether the services will be performed, or the compensation will be received, by the service provider or an affiliate or subcontractor of the service provider. For purposes of the new requirements, (i) a person’s (or entity’s) affiliate is any person (or entity) that directly or indirectly controls, is controlled by, or is under common control with such person (or entity), or that is an officer, director or employee of, or partner in, such person or entity and (ii) a person’s (or entity’s) subcontractor is any person (or entity), other than an affiliate, that reasonably expects to receive $1,000 or more of compensation for performing services under the contract or arrangement with the covered plan. The new requirements apply to the provision of the following services:
· Services provided directly to the plan as an ERISA fiduciary.
· Services provided directly to the plan as an investment adviser registered under either the Investment Advisers Act of 1940 or any state law.
· Services provided as an ERISA fiduciary to an investment contract, product or entity that holds plan assets (as determined under the DOL’s plan asset regulations) and in which the plan has a direct equity investment. (This only covers the first level of the investment contract, product or entity and not any of the underlying investments of the investment contract, product or entity (e.g., a private equity fund deemed to hold plan assets and in which the plan has invested but not any of the investments held by the private equity fund)).
· Recordkeeping or brokerage services provided to an individual account plan (e.g., a 401(k) plan or profit sharing plan) that permits individuals to direct the investment of their accounts, if one or more designated investment alternatives (e.g., mutual funds) also will be made available in connection with the provision of the recordkeeping or brokerage services. (For purposes of the new rules, designated investment alternatives do not include brokerage windows, self-directed brokerage accounts or similar arrangements).
· Services for accounting, auditing, banking, consulting (with respect to investment policies or service providers or plan investments), custodial, insurance, investment advisory (for the plan or participants), legal, recordkeeping, securities or other investment brokerage, third party administration or valuation (i) for which “indirect” compensation will be received by the service provider or an affiliate or subcontractor of the service provider, or (ii) for which the compensation will be paid on a transaction basis (commissions, soft dollars, finders’ fees, etc.) or charged directly against the plan’s investments (and reflected in the net value of the investments) and paid among the service provider, its affiliates or subcontractors. “Indirect” compensation generally means compensation to be received from any source other than the plan, the plan sponsor, the service provider, or an affiliate or subcontractor of the service provider. “Direct” compensation means compensation received directly from the plan. (This category includes unregistered investment advisors who receive the foregoing “indirect” compensation.)
No service provider is subject to the new disclosure requirements solely by providing services (i) as an affiliate or subcontractor of the person or entity who enters into the contract or arrangement with the covered plan, or (ii) to an investment contract, product or entity in which the plan has a direct investment where the investment contract, product or entity does not hold plan assets or the services are provided other than as an ERISA fiduciary. The onus is placed on the plan fiduciary to obtain the required disclosures and the service provider who actually contracts with the plan to provide the required disclosures.
Additionally, non-monetary compensation of $250 or less, in the aggregate, through the term of the contract or arrangement need not be disclosed.
Required Disclosures
Although not required to enter into a formal written contract with the plan, the service provider must disclose, in writing, the following information to the fiduciary of the plan with the authority to cause the plan to enter into, or extend or renew, the service contract or arrangement:
· All direct and indirect compensation reasonably expected to be received by the service provider, its affiliates or subcontractors and a description of the services (including recordkeeping services) for which the compensation is to be paid; the specific services for which any indirect compensation will be received; the payer of any such indirect compensation; and the manner in which the compensation will be received (i.e., whether billed by the service provider or deducted directly from plan accounts). Direct compensation may be disclosed as an aggregate total for all services (e.g., such as for a bundled provider) or itemized for each type of services (except that more specific disclosures are required for recordkeeping services as described below).
· All compensation paid among the service provider and its affiliates and subcontractors if the compensation is paid on a transaction basis (i.e., commissions, soft dollars, finders’ fees, etc.) or is charged directly against the plan’s investments and reflected in the net value of the investment (i.e., Rule 12b-1 fees), including the identity of the services for which the compensation will be paid; the payers and recipients of the compensation and their status as the service provider or an affiliate or subcontractor of the service provider; and the manner in which the compensation will be received (i.e., whether billed or deducted from plan accounts). (This information must be separately disclosed regardless of whether it is required to be disclosed pursuant to any other requirements but does not include any compensation received by an employee from his or her employer.)
· All compensation to be paid in connection with the termination of the service contract or arrangement, and how any prepaid amounts will be calculated and refunded upon termination.
· With respect to each investment contract, product or entity that holds plan assets and in which the plan has a direct equity investment, the fiduciaries to the investment contract, product or entity and, with respect to services provided as an ERISA fiduciary, descriptions of (i) any compensation that will be charged directly against the amount invested by the plan in connection with the acquisition, sale, transfer of or withdrawal from the investment contract, product or entity (e.g., sales loads, sales charges, redemption fees, exchange or discount fees), (ii) the annual operating expenses (e.g., expense ratio) if the return is not fixed and (iii) any ongoing expenses in addition to annual operating expenses (e.g., wrap fees, mortality and expense fees). If recordkeeping or brokerage services are provided, along with designated investment alternatives, to an individual account plan that permits participants to direct the investment of their accounts, the foregoing information also must be provided by the recordkeeper or brokerage service for each designated investment alternative made available to the participants (the service provider will be able to fulfill this requirement by providing the current disclosure materials of the issuer so long as (i) the issuer is not an affiliate of the service provider, (ii) the disclosure materials are regulated by a federal or state agency and (iii) the service provider does not know that the materials are incomplete or inaccurate).
· If recordkeeping services will be provided to the plan, all direct or indirect compensation the service provider will receive for the recordkeeping services and the manner in which the compensation will be received. If recordkeeping services will be provided without explicit compensation, or when recordkeeping services are offered or rebated based upon other compensation, a reasonable good faith estimate of the cost of the recordkeeping services, including how they are calculated and the assumptions used, must also be provided. The estimate should take into account (i) the rates the service provider charges to unrelated third parties, or (ii) the prevailing market rates charged for similar services to similar plans.
· If applicable, a statement that the service provider or its affiliate or subcontractor expects to provide services as an ERISA fiduciary and/or an investment advisor registered under the Investment Advisors Act of 1940 or any state law.
Generally, the required disclosures must be provided within a reasonable time before the date the service contract or arrangement is entered into, extended or renewed (the DOL regulation does not provide a specific advance timeframe). Additionally, service providers must disclose any change (note the omission of the word “material”) to the information initially provided as soon as practicable, but not later than 60 days after the date the service provider is informed of the change. This deadline is extended (i) where the investment contract, product or entity is determined to hold plan assets (after an initial determination to the contrary) and (ii) where the investment alternative is designated after the contract or arrangement is entered into, extended or renewed.
The service provider may disclose the compensation to be received as a fixed dollar amount, a formula, a percentage of covered plan assets, or a per capita charge for each covered participant, or, if not reasonably able to be disclosed in those terms, by any other reasonable method that is sufficient to evaluate the reasonableness of the compensation.
Consequences for Failure to Comply
Failure to follow the new rules results in the plan fiduciary and service provider engaging in a prohibited transaction with the attendant adverse consequences. However, the plan fiduciary will not be deemed to have violated its fiduciary obligations to ensure that arrangements with service providers are reasonable if the service provider makes an error or omission in disclosing the required information, despite the good faith efforts and reasonable diligence of the service provider. In that case, the service provider must make the required disclosure within 30 days after discovering the error or omission.
Additionally, if a required disclosure is not provided, the plan fiduciary will not be subject to the prohibited transaction penalties if the plan fiduciary (i) did not know of the failure and reasonably believed that the required information was disclosed, (ii) upon discovering the failure, requests the information in writing from the service provider, (iii) if the service provider fails to comply with the written request within 90 days or otherwise refuses to provide the information, notifies the DOL of the failure within 30 days of the expiration of the 90 days for a response or the refusal to provide the information, if earlier, and then (iv) considers whether to terminate the contract or arrangement for failure by the service provider to disclose the required information. (The DOL has provided a model notice to make this notification.)
If the contract or arrangement constitutes a prohibited transaction, the service provider generally will be required to pay an excise tax of 15% of the amount of the compensation that is deemed to be unreasonable (which in this case would be the full compensation paid under the contract or arrangement). The excise tax could pyramid on itself and increase if the contract or arrangement is outstanding more than one year and also could increase to 100% if the contract or arrangement is not ultimately unwound and corrected. Plan fiduciaries, acting in such capacity, are not generally subject to excise taxes as the result of a prohibited transaction; however, plan fiduciaries will be personally liable for any losses the plan incurs, and the DOL may impose on the plan fiduciary an additional 20% penalty on any amount recovered in connection with the breach by the fiduciary of any of its fiduciary duties under ERISA.
Application of New Rules
Although the new requirements are designed to apply to a broad category of service providers, the class of service providers covered by the new requirements is actually narrower than the class of service providers subject to the reporting requirements of Schedule C of the Form 5500. For example, the following types of fees generally will not be subject to the new fee disclosure requirements (assuming they are not charged on a transaction basis): (i) annual plan audit fees paid by the plan or plan sponsor, (ii) ESOP appraisal fees paid by the plan or plan sponsor, (iii) consulting fees that do not relate to the development or implementation of investment policies or objectives, or the selection or monitoring of service providers or plan investments and (iv) legal fees paid by the plan or plan sponsor.
What You Should Do Next
Because failure to comply with the new disclosure rules has adverse consequences, there will be significant incentives for service providers to provide, and plan fiduciaries to obtain and assess, the information required under the new rules. In preparation for the regulation’s effective date next year, plan service providers should begin (i) evaluating their current fee disclosures and (ii) determining what changes or additions will be required. Plan fiduciaries should begin (i) identifying service providers from whom they will need to receive the required disclosures and (ii) implementing a system to obtain the appropriate information and monitor any changes thereto. Plan fiduciaries, however, should be aware that compliance with the new disclosure rules is independent of any other fiduciary obligations that they otherwise have with respect to service contracts and arrangements between plans and their service providers.
If you have any questions about the new guidance, please contact any member of the Troutman Sanders’ Employee Benefits & Executive Compensation Practice Group.