The U.S. Department of Labor (DOL) issued interim final regulations outlining the requirements that service providers must follow to disclose fees to plan fiduciaries. The rules were issued on July 15, 2010, and take effect on July 16, 2011. [Update: A separate final rule issued by the DOL on Oct. 14, 2010, addressed required disclosure of fees by plan sponsors to plan participants.]
Plan sponsor fiduciaries are required by law to ensure that retirement plan fees are reasonable and that any conflicts of interest that might exist with a service provider are addressed. The DOL’s intent is to provide a framework by which providers can disclose information fully so fiduciaries will be provided with all they need.
Which Plans Have to Comply with These Rules?
A “covered plan” is defined as an ERISA employee pension benefit plan or a pension plan. This covers all types of qualified retirement plans, including 401(k), ERISA 403(b), profit sharing, money purchase pension, defined benefit pension, employee stock ownership and stock bonus plans.
The following types of plans are not covered plans: government plans, non-ERISA 403(b) plans, church plans, workers' comp, unemployment compensation or disability insurance plans, nonresident alien plans, unfunded excess benefit plans, simplified employee pension (SEP) plans, SIMPLE retirement accounts and individual retirement accounts or annuities (IRAs).
Which Service Providers Must Provide the Required Information?
A “covered service provider” is a provider that enters into a contract or arrangement with the retirement plan and expects to receive $1,000 or more in direct or indirect compensation for services to the plan, regardless of whether the services are performed by the covered service provider, an affiliate or a subcontractor.
The following are covered service providers:
• ERISA fiduciaries providing services directly to the plan.
• Investment advisors registered under the Advisors Act or state law providing services directly to the plan.
• ERISA fiduciaries providing services to an investment contract, product or entity that holds plan assets and in which the covered plan invests. They are considered ERISA fiduciaries even though they provide services to a plan asset, rather than directly to the plan. They must disclose compensation information about the investment vehicle for which they serve as a fiduciary.
• Providers of recordkeeping and/or brokerage services to an individual account plan that allows participants to select investments from one or more designated investment alternatives. This does not include a self-directed brokerage account that allows participants to select investments beyond the investments designated for the plan.
• Providers who receive indirect compensation (defined below) for: accounting, auditing, actuarial, appraisal, banking, consulting, custodial, insurance, investment advisory (for plan or participants), legal, recordkeeping, securities or other investment brokerage, and third-party administration or valuation services to the covered plan. The DOL defines consulting services to include only development or implementation of investment policies or objectives, or the selection or monitoring of service providers or plan investments.
What Information Must Be Provided?
Covered service providers must provide written disclosure. However, the rules do not require a formal written contract or arrangement. The following information must be included:
• Services – a description of the services to be provided to the covered plan according to the contract or arrangement (not including services provided by a non-fiduciary service provider to investment vehicles holding plan assets).
• Status – where applicable, a statement that the covered service provider (or an affiliate or subcontractor) will provide their services as a fiduciary or as a registered investment advisor registered under the Advisors Act or any state law.
• Compensation – a description of the following compensation made to a covered service provider, an affiliate or a subcontractor:
✔ Direct compensation payments received directly by the covered plan.
✔ Indirect compensation payments received from a source other than the covered plan, plan sponsor, covered service provider, an affiliate or a subcontractor.
✔ Per-transaction compensation (i.e. commissions, soft dollars, finder’s fees, or other similar arrangements).
✔ Compensation charged directly against the covered plan’s investments and reflected in the net value of the investments (i.e. 12b-1 fees).
✔ Compensation paid in connection with a termination of the contract or arrangement and any refunds of prepayments.
• Recordkeeping services – a description of all recordkeeping-related direct and indirect compensation. If these services are bundled with other services and the fees cannot be segregated, or the fees are offset or rebated by other compensation received by the covered service provider, a reasonable good faith estimate must be provided to the fiduciary including an explanation of how the estimate was derived.
• Manner of receipt – a description of how the compensation will be received. For example, the covered service provider should stipulate whether it will bill for the services or deduct the compensation directly from the covered plan’s assets.
• Investment disclosure of fiduciary services – fiduciaries providing services to an investment contract, product, or entity that holds plan assets, should provide:
✔ A description of any charges against the amount invested in connection with the acquisition, sale, transfer of, or withdrawal from the investment contract, product or entity (i.e. sales loads or charges, deferred sales charges, redemption fees, surrender charges, exchange fees, account fees, and purchase fees).
✔ A description of annual operating expenses if the return is not fixed (i.e. expense ratio).
✔ A description of any ongoing expenses in addition to annual operating expenses (i.e. wrap fees, mortality and expense fees).
• Investment disclosure of recordkeeping and brokerage services – recordkeepers and brokers that make available investment alternatives for participant-directed individual account plans must disclose the same investment-related compensation described above under fiduciary services. It must be provided for each investment alternative for which recordkeeping or brokerage services will be provided.
Covered service providers may provide the current disclosure materials from the investment’s issuer if: 1) the issuer is not an affiliate, 2) the materials are regulated by a state or federal agency, and 3) the service provider does not know that the materials are inaccurate or incomplete.
When Must the Information Be Provided?
• Initial disclosure – covered service providers must disclose the required information to responsible plan fiduciaries before the contract or arrangement is finalized with sufficient lead time to allow the responsible fiduciary ample time to evaluate the information before a contract goes into place or before selecting or changing an investment alternative within the plan. For existing contracts or arrangements, conforming written disclosure must be provided by July 16, 2011.
• Changes to the required information – any changes to the required information must be provided to the fiduciary no later than 60 days from the date the covered service provider makes a change or is made aware of a change.
• Written requests by fiduciary – the responsible fiduciary may request additional information relating to compensation received in connection with the contract and the provider must disclose the required information no later than 30 days following receipt of a written request.
What Happens If a Service Provider Doesn’t Comply?
• Ramifications to the service provider – if a covered service provider fails to meet the disclosure requirements, the contract or arrangement will not be “reasonable” and fees paid to that service provider will be considered a prohibited transaction. Prohibited transaction penalties of 15 percent of the fees involved will apply and compound annually until the disclosure is corrected or the contract is terminated. The service provider will be responsible to pay this penalty. Also, to correct this prohibited transaction, the fees involved should be paid back.
Oviously, it is in everyone’s best interest to avoid this situation, but DOL guidance issued to date is not comprehensive. For example, are all fees considered a prohibited transaction or just those fees not properly disclosed? Based on the DOL’s regulation overview, it appears that the entire contract/arrangement will be “unreasonable” if the service provider fails to disclose one or two items, suggesting that the entire fee (even those fees where proper disclosure occurred) would be considered a prohibited transaction. This doesn’t seem reasonable in our opinion.
A contract or arrangement will not be considered unreasonable if the covered service provider, acting in good faith, makes an error or omission in disclosing information as long as the covered service provider discloses the correct information no later than 30 days after the error or omission is discovered.
• Ramifications of noncompliance to fiduciary – if the covered service provider fails to disclose the required information under this final rule, the responsible plan fiduciary will have violated their fiduciary duty because they caused the plan to engage in a prohibited transaction by hiring the covered service provider. For protection from this violation, a fiduciary should file for a prohibited transaction exemption with the DOL. This exemption is available if:
✔ The fiduciary did not know that the covered service provider failed to make the required disclosures and reasonably believed that the information disclosed met the requirements.
✔ On discovery that the covered service provider failed to adequately disclose, the fiduciary requests in writing that the provider disclose the required information.
✔ On failure of the service provider to provide the required information, the fiduciary notifies the DOL no later than 30 days following the date that the covered service provider’s refusal to furnish the required information or 90 days after the fiduciary’s written request.
✔ The fiduciary provides the DOL with certain information, including the names of parties, contact information, plan numbers, service descriptions, description of information the covered service provider failed to provide, dates of importance and a statement as to whether the service provider continues services for the plan.
What Should Plan Sponsor Fiduciaries Do Next?
For existing contracts or arrangements, written disclosures that meet these requirements must be provided by July 16, 2011.
Service providers have the challenge of evaluating and determining whether they are covered service providers and whether their current contract/arrangements meet these new requirements. Changes to written disclosures more than likely will be required, and this will be no small feat for service providers.
As the deadline approaches, fiduciaries will want to request the information from covered service providers.
What Should Service Providers Do Next?
In preparation of the rules effective in 2011, service providers should:
• Evaluate all contracts to determine if they meet the new requirements.
• If the contracts do meet the new requirements, notify the fiduciaries of this in writing.
• If a contract does not comply, modify the contract accordingly and provide the new contract no later than July 16, 2011, to the plan fiduciaries.
Judy Simons, CPC, QPA, QKA is vice president and senior consultant for compliance services at TRI-AD, an employee benefits administration firm based in Southern California with over 1,000 clients nationwide. She has many years of experience designing, administering and consulting for defined benefit pension plans and defined contribution plans including 401(k), profit sharing, money purchase, target benefit pension, stock bonus and employee stock ownership plans.
© 2010 TRI-AD. All rights reserved. Reposted with permission.
This article was originally published in the September 2010 issue of TRI-AD NewsLink.
DOL Issues Final Rule on 401(k) Fee Disclosure to Participants, SHRM Online Benefits Discipline, October 2010
Control 401(k) Costs with a Zero Revenue-Sharing Strategy, SHRM Online Benefits Discipline, September 2010
DOL Issues Interim Final Rule on Disclosing Retirement Plan Fees (to plan sponsors), SHRM Online Benefits Discipline, July 2010
401(k) Fees Matter: Tips for Reining Them In, SHRM Online Benefits Discipline, August 2008
Excessive 401(k) Fees Fought, SHRM Online Legal Issues, April 2007
SHRM Online Benefits Discipline